Total Return Strategy vs. Income and Dividend Strategy for a Nestegg

[Hamlet]

I think that the advantage of targeting dividend payers is that they are usually strong existing businesses where management is less likely to be destroying capital by trying to re-invest it in businesses they know nothing about, or in a core business that doesn't require any more capital.

Take McDonald's. They are a very good business, but there isn't going to be much growth going forward for them. Rather than have them try to buy other businesses that they might run badly or overpay for, or try to open restaurants that will cannibalize sales from their existing stores, I would much prefer that they pay dividends and buy back stock (assuming their share price is reasonable). That is part of my return from a great business that management can't destroy.

Much of what Corporate America does is destructive to capital. All of the dumb M&A, or trying to expand into non-core businesses, or the constant re-orging. A rising dividend over decades is a signal to me that the company has management in place that destroys less capital over time than the average group of nimrods in charge of companies in this country.

For the used car analogy-- I would bid somewhat less than $50 for the $50 bill in the car, because there is a decent chance someone will grab it and spend it on fancy mudflaps before they turn the car over to me after I buy it.

So while I invest for a total return, I certainly trust most of the businesses with a long history of increasing dividend payouts more than the average company.

[mathjak107]

what is interesting is dividends increased to the highest levels since 1998 with a record increase of 17.8 billion dollars in increased divends payed out just 1st quarter. the 2nd quarter may be even bigger.

all dow stocks pay divdends and 84% of the s&p 500 does too.

but according to a study done by howard silverblatt at s&p those dividends have been coming at a price as they go up and up..

a good part of that capital from free cash flow is gone forever and no longer available for compounding .

mid-caps and small caps who pay little in dividends have been far and away providing far better compounding and use of investor money for much greater returns..

in fact one of the least efficiant ways to grow investor money now is paying it out as a dividend.

as chuck akre said ,free cash flow in a company can be used to compound by buying back its own stock, investing in its own company or buying other companies . cash flow paid out as a dividends loses its compounding ability and much of it is gone forever and can no longer compound.

many of the great companies in the s&p 500 have lagged behind their non dividend payers in the midcap and small cap markets who now seem to be much more efficient at generating compounding on investor money.

midcaps and small caps have compounded the last few years 5-6% higher then their dividend paying cousins.

[samclem]

Quote:

Originally Posted by Hamlet That is part of my return from a great business that management can't destroy.

You may be underestimating the power of inept management. The dividend check in hand is secure, all future ones depend on scores of things in and out of the control of company management.

Kodak, JC Penney, Citigroup, Barnes and Noble--all paid solid dividends for a long time.

[Mulligan]

Quote:

Originally Posted by samclem You may be underestimating the power of inept management. The dividend check in hand is secure, all future ones depend on scores of things in and out of the control of company management. Kodak, JC Penney, Citigroup, Barnes and Noble--all paid solid dividends for a long time.

One thing is sure.... Whenever management has to come out and say....."The dividend is secure", that is when I would start to get nervous.


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[Hamlet]

Quote:

Originally Posted by samclem You may be underestimating the power of inept management. The dividend check in hand is secure, all future ones depend on scores of things in and out of the control of company management. Kodak, JC Penney, Citigroup, Barnes and Noble--all paid solid dividends for a long time.

Sure, but at least two of those businesses were destroyed by technology changes more than inept management. Barnes and Noble and Kodak weren't destroyed primarily by mismanagement- they just made buggy whips.

Dividends are no guarantee, they are just an indication that management has some regard for shareholders, since paying a dividend makes the business somewhat smaller than it could be, and management is usually paid based more on the size of the business than its quality.

[photoguy]

Wasn't kodak one of the very first companies to research and start pushing digital cameras and sensors? I think under better management they could have navigated the shift much more successfully.

[samclem]

Quote:

Originally Posted by photoguy Wasn't kodak one of the very first companies to research and start pushing digital cameras and sensors? I think under better management they could have navigated the shift much more successfully.

Yes, they were in the digital biz at both the consumer and commercial levels. I don't know what they did wrong--they had a very powerful brand name and it seems they could have made something of it.
There are very few companies still doing business as they were 15 years ago, much less 50. If a company makes buggy whips, or has depended on out-of-date sales methods, etc, it is the responsibility of management to see the need for change and make it happen.

[HadEnuff]

Very interesting discussion. thanks to all.

[mathjak107]

Quote:

Originally Posted by Hamlet I think that the advantage of targeting dividend payers is that they are usually strong existing businesses where management is less likely to be destroying capital by trying to re-invest it in businesses they know nothing about, or in a core business that doesn't require any more capital. Take McDonald's. They are a very good business, but there isn't going to be much growth going forward for them. Rather than have them try to buy other businesses that they might run badly or overpay for, or try to open restaurants that will cannibalize sales from their existing stores, I would much prefer that they pay dividends and buy back stock (assuming their share price is reasonable). That is part of my return from a great business that management can't destroy. Much of what Corporate America does is destructive to capital. All of the dumb M&A, or trying to expand into non-core businesses, or the constant re-orging. A rising dividend over decades is a signal to me that the company has management in place that destroys less capital over time than the average group of nimrods in charge of companies in this country. For the used car analogy-- I would bid somewhat less than $50 for the $50 bill in the car, because there is a decent chance someone will grab it and spend it on fancy mudflaps before they turn the car over to me after I buy it. So while I invest for a total return, I certainly trust most of the businesses with a long history of increasing dividend payouts more than the average company.

the failed product and business's grave yard is full of failed ventures by s&p 500 company's . if you don't trust the mgmt of a company to act responsible perhaps you should not own the stock regardless .

i don't need them to give me back my own money . i can sell any stock and take a bit out if i wanted .

most folks reinvest the dividends back in the same company anyway .

[Mulligan]

Quote:

Originally Posted by mathjak107 the failed product and business's grave yard is full of failed ventures by s&p 500 company's . if you don't trust the mgmt of a company to act responsible perhaps you should not own the stock regardless . i don't need them to give me back my own money . i can sell any stock and take a bit out if i wanted . most folks reinvest the dividends back in the same company anyway .

Although it may not be a stock that is suited for you, but a utility common stock would be an example of a company that if owned you would want the dividend. These companies are growth constrained by there very nature. History has not usually been kind to ones that have tried the other strategy.


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[mathjak107]

it really wouldn't matter . if they retained whatever growth they had in the share price instead i can take a piece whenever i wanted .

in either case the total return is the total return no matter how you get it .

[Mulligan]

Quote:

Originally Posted by mathjak107 it really wouldn't matter . if they retained whatever growth they had in the share price instead i can take a piece whenever i wanted . in either case the total return is the total return no matter how you get it .

I agree...But that is the realm of theoretical. In reality, cash sitting on the balance sheet causes all sorts of problems from meddling activists, to buyout specialists using the cash against the company, to external pressure to invest in what isn't in the best interest of a utility. It has been tried before and with bad results.


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[mathjak107]

i think it boils down to you are either happy with the total return or you aren't

them handing me back my money and saying go find another investment really wouldn't do much for me in my accumulation stage . i would just find an investment that could compound my money .

on the other hand in retirement , at the end of the day it will only be about the total return when spending down . how it is arrived at is a moot point .

the return either meets goal or it doesn't .

since i buy only diversified funds what goes on in any one company does not really concern me . i have a mix of dividend paying funds and growth funds . at the end of the day they have to meet my retirement goals . how they get there is not so much a concern .

[Mulligan]

We aren't in disagreement. Just providing a little twist to the thread since it is getting a bit repetitive. A complete "total return" investor may thus have little interest in utilities. As they by the forced nature of the company become "bond type" proxies.


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[Hamlet]

Quote:

Originally Posted by mathjak107 the failed product and business's grave yard is full of failed ventures by s&p 500 company's . if you don't trust the mgmt of a company to act responsible perhaps you should not own the stock regardless . i don't need them to give me back my own money . i can sell any stock and take a bit out if i wanted . most folks reinvest the dividends back in the same company anyway .

My point is that a dividend is a great signal that they are acting responsibly. Many large companies have great core businesses that are much, much better than the average business. Many of those businesses can't deploy unlimited capital into those great businesses though. Rather than have them expand into poor businesses, I'd rather just have them deploy the capital that they can into the great businesses, and send me back the remainder.

Take Coke. For a long time in the 70s and early 80s, they took the profits from a great business and invested them in a whole slew of marginal businesses (shrimp farming was actually one of them). The overall return of the business was lackluster. I'd rather they just keep selling Coke, re-invest as much as makes sense into that business, and send me the excess in dividends or stock buybacks (when the stock is reasonably priced).

I can find other places to put the money. I'd rather own great businesses than the hodgepodge of junk that most companies end up with when they decide they can deploy the capital into other businesses with as much success as they have had in their core business.

Berkshire is the exception that proves the rule here for me. I trust Buffet to redeploy capital intelligently. That's what he is good at.

The managers of Coke, McDonald's, Microsoft, Fastenal, ADP, Walmart, Exxon, ect, are good at running their core businesses. They aren't always going to be good at deploying capital outside that circle of competence though. They also have an incentive to overpay for purchased businesses, because as a rule, the bigger the business gets (regardless of the return on capital), the more they are likely to get paid. So if management is good enough to say "keeping this capital will not get the same return on investment in our great business that the existing capital gets, our shareholders should find other great places to invest this money rather than have us deploy it sub-optimally", I take that as a really good trait in management.

[Hamlet]

Quote:

Originally Posted by mathjak107 the failed product and business's grave yard is full of failed ventures by s&p 500 company's . if you don't trust the mgmt of a company to act responsible perhaps you should not own the stock regardless . i don't need them to give me back my own money . i can sell any stock and take a bit out if i wanted . most folks reinvest the dividends back in the same company anyway .

Note that me reinvesting the dividends back in the same company gives me a larger share of their core great business rather than having that great business diluted by having them re-invest the money in a business getting a lower return.

[mathjak107]

true but if you don't trust the mgmt. then I can't see being in the stock .

[Running_Man]

Quote:

Originally Posted by mathjak107 true but if you don't trust the mgmt. then I can't see being in the stock .

Every individual should invest in what they are comfortable with, I am comfortable requiring dividends on my stocks and this is why:

When I take my money and invest it in stocks, I am looking for someone to lead a company with goals that align with mine and I trust none of them I expect regular reports and an annual audit by a respected auditing firm. Management adjusted numbers are typically taken for with a very large grain of salt as I prefer to look at financial statements from a GAAP perspective.

1) I expect an annual dividend initially upon investment over 1.5% annually and that the dividend will grow at least a minimum of twice the inflation rate over time. The amount of earnings allocated to the dividend should be between 20 percent and 60 percent. I expect this because a portion of the money earned I will need for either living expenses or to invest in other endeavors. I am not going to count on the valuation metrics of other investors to determine what the earnings are worth to provide these funds to me as my CEO has no control over those valuations but does have control over the earning performance of the company which provides for the dividends.

2) There should meetings quarterly to discuss the published financial results and take questions from other owners and interested parties in the business and lead to confidence the CEO and his staff understand the business and have good plans for growth going forward. If the CEO states that the dividend must be cut or not grown in order to provide for future growth I will no longer have that CEO work for me and will withdraw my funds from the company and into another.

3) How well a CEO can perform in growing a company while paying an adequate dividend is easily followed in the published financial results and future expectations are more easily measured and compared. Many companies are monitored in expectation that a CEO might become very disappointing to me, even after a good performance with him, Yes Richard Kinder I am thinking of you right now....

4) The goal is to create a stream of income that grows at twice the rate of inflation over time, how the other investors are valuing companies only affects me if I see the dividend percentage has declined below 1.5% due to an increasing stock price (dividend percentage that occurs because dividend decreased is always sold, hopefully long before it is cut) or if I feel valuations of companies as a whole has gotten to a level where I should for a time reduce my exposure to common stock equities.

If I succeed in these goals over time I have seen the prices of my investments have done very well, which should occur if these conditions are met, but my fellow investors are a rather fickle lot and you never know the time they are willing to drop prices by 50 percent.

[Hamlet]

Quote:

Originally Posted by mathjak107 true but if you don't trust the mgmt. then I can't see being in the stock .

It's one thing to trust a manager to run a great existing business that they've spent 20+ years working in, and quite another to trust them to acquire new businesses and expect them to do as well with them.

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact." -- Warren Buffett

"Buy into a business that’s doing so well an idiot could run it, because sooner or later, one will.'” -- Warren Buffett

[Mulligan]

Quote:

Originally Posted by Running_Man Every individual should invest in what they are comfortable with, I am comfortable requiring dividends on my stocks and this is why: When I take my money and invest it in stocks, I am looking for someone to lead a company with goals that align with mine and I trust none of them I expect regular reports and an annual audit by a respected auditing firm. Management adjusted numbers are typically taken for with a very large grain of salt as I prefer to look at financial statements from a GAAP perspective. 1) I expect an annual dividend initially upon investment over 1.5% annually and that the dividend will grow at least a minimum of twice the inflation rate over time. The amount of earnings allocated to the dividend should be between 20 percent and 60 percent. I expect this because a portion of the money earned I will need for either living expenses or to invest in other endeavors. I am not going to count on the valuation metrics of other investors to determine what the earnings are worth to provide these funds to me as my CEO has no control over those valuations but does have control over the earning performance of the company which provides for the dividends. 2) There should meetings quarterly to discuss the published financial results and take questions from other owners and interested parties in the business and lead to confidence the CEO and his staff understand the business and have good plans for growth going forward. If the CEO states that the dividend must be cut or not grown in order to provide for future growth I will no longer have that CEO work for me and will withdraw my funds from the company and into another. 3) How well a CEO can perform in growing a company while paying an adequate dividend is easily followed in the published financial results and future expectations are more easily measured and compared. Many companies are monitored in expectation that a CEO might become very disappointing to me, even after a good performance with him, Yes Richard Kinder I am thinking of you right now.... 4) The goal is to create a stream of income that grows at twice the rate of inflation over time, how the other investors are valuing companies only affects me if I see the dividend percentage has declined below 1.5% due to an increasing stock price (dividend percentage that occurs because dividend decreased is always sold, hopefully long before it is cut) or if I feel valuations of companies as a whole has gotten to a level where I should for a time reduce my exposure to common stock equities. If I succeed in these goals over time I have seen the prices of my investments have done very well, which should occur if these conditions are met, but my fellow investors are a rather fickle lot and you never know the time they are willing to drop prices by 50 percent.

I thoroughly understand the "theory" of total return vs. income, and understand fully both sides of the issue. But I only care about reality. And the reality of the situation for me is... "If there is no dividend there is no purchase!"


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